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Holes in industrial ecosystems threaten manufacturing

U.S. structures affect scaling of innovation; productivity key for Japan as wage gaps narrow

by Takashi Kitazume

Staff Writer

Even in a globalized economy, nations need to have strong local production capabilities in order to bring innovation to the market, American and Japanese scholars said in a recent symposium held in Tokyo.

The United States should fix the holes in its “industrial ecosystems” — involving suppliers, research, skilled labor as well as financing — that were created with the changes in its corporate structures since the 1980s. Meanwhile, the productivity of Japanese manufacturers has once again become more important as wage gaps between advanced and emerging economies rapidly narrow, they said.

Professors from the Massachusetts Institute of Technology were joined by Japanese scholars as well as business executives and a government official during the symposium held March 28 under the theme, “Manufacturing in the Innovation Economy.” In the event jointly organized by the Japan Program at the MIT Center for International Studies, Keidanren (Japan Business Federation ) and the Keizai Koho Center, the participants discussed the future of manufacturing as jobs in this sector continue to decline in Japan and the U.S.

“We know that innovation still remains very strong in the U.S., but the question is, do we actually have the kinds of capabilities that we need in order to get full value from our own innovation” in terms of creation of jobs and new businesses, asked Suzanne Berger, an MIT professor of political science, as she cited extensive research involving 20 faculties of MIT that interviewed about 250 companies in the U.S., China and Germany.

What went wrong with manufacturing in the U.S., where millions of jobs were lost in the sector over the last decade? Globalization and the opening of the U.S. market to low-cost labor markets like China’s has indeed had an enormous impact on manufacturing jobs in the U.S., but an important and often forgotten change in the U.S. economy — a change in American corporate structure — “came long before globalization really hit,” she said.

Up to the 1980s many of the big U.S. companies were vertically integrated “where research, development, design, production and marketing all took place within the four walls of the company,” she said. “Today we have companies that have drastically pared down their activities. Under the pressure from financial markets, many of these larger American companies moved production entirely out of the corporation and transferred to low-cost manufacturing sites in other countries. This fragmentation of companies, distribution of functions, creation of supply chains between firms in the U.S. and contract manufacturers elsewhere in the world has been a tremendous change in the corporate structure of our economy.”

This change, Berger said, has created opportunities, where people who have innovative ideas do not have to create big companies or build all the production facilities to bring the innovation to the market, but they can access production capabilities outside the U.S.

But there are also problems associated with this new model, the professor said. “When innovation grew up within big, vertically-integrated companies, they had the resources to scale up their innovation. Today when innovation grows up out of university labs and startup firms, where does the money come from?

“In the old world of vertically-integrated firms, large employers used to have apprenticeships — they provided skills and training,” she said. “Today the average size of companies is much smaller, and they’re not willing to put funds into training workers. Workers move far more frequently than they did in the past, so companies are not interested in investing in training.”

In its assessment of the inputs required to bring innovation to the market — worker skills, capital, suppliers, technical expertise, facilities and policies — the MIT research concludes that the U.S. needs strong manufacturing capabilities at home — along with access to overseas production — “to support our innovative capabilities,” Berger said.

“Innovation is not just about patents. There’s extraordinary potential across much of the U.S., but the fact is that these firms can no longer draw on public goods like training and research consortia that would be of use to them as they try to bring their innovation to scale,” she said.

“What we see as the greatest challenge for American innovation is to be able to rebuild those resources in the industrial ecosystem that would allow smaller companies, medium-sized companies and even our large companies to be able to scale their innovative ideas,” Berger said.

“No company can create within its own four walls all the resources it needs to be able to bring its ideas to market. We need to think about how to repair those holes in the industrial ecosystems that were created in the transformation of corporate structures, and the way to repair these holes and create these resources is by building institutions that would allow us to coordinate, to pool risks and reduce risks and to bring both public institutions and private companies together,” the professor said.

Takahiro Fujimoto, a professor and the executive director of the Manufacturing Management Research Center at the University of Tokyo, also stressed the importance of retaining manufacturing capabilities at home, especially as Japan, unlike economies such as the U.S., has no strong agriculture or service sector that it can sell in overseas markets but has to rely on manufacturing.

And while the past 20 years have seen a large portion of Japan’s manufacturing operations moved offshore to low-cost economies like China, it’s the productivity — rather than currency exchange rates or wage levels — that will hold the key to international competitiveness in coming years, Fujimoto said.

A decade ago, average wages in China were one-twentieth the levels in Japan. But now the gap is rapidly narrowing because of rising wages in China, which have gone up to levels around one-eighth to one-seventh of those in Japan, Fujimoto pointed out.

When there was a gap as wide as 20 times in wage levels with the low-cost economies, raising productivity in manufacturing plants in Japan did not help much in terms of competitiveness, he said. With the rising wages in many of those economies, however, simply moving production to those countries will not guarantee a competitive edge — unless productivity of those overseas plants themselves improves, he added.

And it will have to be the “mother plants” of the manufacturers in Japan — which have survived the tough conditions such as the yen’s appreciation and competition with low-cost economies for decades — that need to teach the overseas plants how to increase productivity, Fujimoto said.

What Japanese manufacturers need to do, he said, is to boost production capabilities at domestic plants and pursue offshore production at the same time. There is still room for substantial productivity gains at many of the surviving manufacturing plants in Japan, while moving plants to low-cost economies for wage considerations alone will no longer make them competitive as export bases, the professor said.

The discussion in the U.S., and perhaps in Japan as well, about manufacturing and innovation has been motivated to a large extent by the rise of China as an economic powerhouse, and today Chinese manufacturers have become a key part of the global ecosystem for some U.S. and European firms by linking their innovations to downstream production, said Edward Steinfeld, a professor of political economy and director of the MIT China Program.

“In some industries, the ecosystem for innovation is global, and for certain North American and European innovators, they are dealing with Chinese firms who are simultaneously their customers but also their co-developers of technology,” Steinfeld said, adding that disruptions to that relationship causes problems for the U.S. and European companies.

MIT research suggests that in China, especially in new technology sectors such as renewable energy, “certain types of world-class, innovative manufacturers have developed,” he said. “There are unique capabilities in certain portions of the Chinese ecosystem. The ability of the North American and European innovative firms to access these capabilities is critical to their ability not just to innovate but to make money and command market share.”

China today is no longer the least expensive place to manufacture the products, but the best Chinese firms have developed the ability to manage fast-paced scaling and cost reduction, Steinfeld said. “If you are an innovator and if you want to scale your innovation quickly, and all the while realize cost reduction, the Chinese ecosystem has become very attractive.”

Paul Osterman, a professor of human resources and management at the MIT Sloan School of Management, discussed the issue of the industrial ecosystem in the U.S. from the viewpoint of skill requirements in today’s manufacturing sector, and the system for the training of skilled workers.

A major question confronting American manufacturers, he said, is what sets of skills are needed in the workforce as the firms seek to compete more effectively — and whether those skills are available in the U.S. Are the skill demands rising so rapidly that there is a shortage of people with extensive education, and if so, does that pose a handicap for American manufacturers because they can’t find the workers they need?

Research shows that the skill demands at U.S. manufacturers has risen only modestly, making most jobs still accessible to most people, Osterman said, adding that roughly 75 percent of U.S. companies are able to find the workers they need within weeks.

However, the remaining 25 percent of the firms — which tend to be smaller and engage in innovative activities — are in fact having difficulty finding the workers with the advanced skills they need, he said. This problem of skill shortage, the professor said, could potentially be exacerbated with the retirement wave of skilled people in the current workforce.

“The American system for producing skills has deteriorated,” Osterman said, noting that large U.S. firms do not offer as much training for their workers as they used to. The human resources functions of U.S. firms — which lagged behind their Japanese counterparts in the past — are even weaker today, he said.

As some of the possible policy responses, Osterman stressed the importance of the role played by intermediaries — either public institutions or business associations — that connect the education institutions and companies that need the human resources. He also called for improving the functions of community colleges in the U.S. — mostly two-year institutions that provide vocational training.

Extensive on-the-job training for the workers has long been considered one of the strong features of Japanese manufacturers, but that is undergoing change as manufacturing processes at large Japanese firms also become globally dispersed, said Satoshi Sumida, general manager of Toshiba Corp.’s Corporate Productivity Planning Division.

Up to around 2000, production of the Toshiba group mainly took place at its domestic plants, where various production processes were clustered, and workers at these plants had many opportunities to learn a wide range of processes, and they built up skills through experience, Sumida said.

Roughly after the turn of the century, production became dispersed — to an increasing number of plants at low-cost economies, he said. Unlike the earlier system of vertical integration within the group, Toshiba increased collaboration with outside suppliers, and the product cycle became shorter. These changes altered the environment for training of the workers, who tend now to be exposed to only part of the production process and have less time and opportunities for on-the-job learning, Sumida noted. In addition, the decline in the number of veteran skilled workers meant reduced opportunities for those skills to be transferred to the younger workers, he said.

One of Toshiba’s responses to these changes, he said, was to turn the “tacit” knowhow that the skilled workers used to accumulate through years of experience into more manualized knowledge that can be shared by an organization — in the form of rules, work flow and design standards, Sumida said.